Why Gold Mining Stocks Are Bargain Priced in the Current Market

by: Dennis Boyko

While gold continues trading within a few percentage points of its all time high in recent months, the major gold producers such as Barrick Gold (NYSE:ABX) and Goldcorp (NYSE:GG), intermediates such as Agnico-Eagle (NYSE:AEM) and Eldorado (NYSE:EGO), and juniors such as Rubicon (RBY) and US Gold (NYSE:UXG) are well off their 52 week highs. Comparing the gold spot market prices with the market capitalization per ounce of gold equivalent for the above gold stocks on a change from 1 day ago, 1 week ago, 2 weeks ago, 4 weeks ago and 13 weeks ago, illustrates the positive divergence in spot price of gold over the valuations the market is assigning to gold stocks (all prices are relative to June 7, 2011 and are based on closing market prices).m

Changes in Gold Spot Market Prices and Gold Stock Market Capitalization per Ounce of Gold Equivalent Over The Last Quarter (relative to June 7/11)

Jun 6


May 31

(-1 week)

May 24

(-2 weeks)

May 10

(-4 weeks)

Mar 8

(-13 weeks)

Gold 0% 0.5% 1.2% 1.7% 7.6%
ABX -0.2% -4.2% -3.4% -4.4% -
GG -0.6% -2.4% -3.2% -2.3% 0.5%
AEM 0.3% -0.7% -0.3% 1.7% -12.3%
EGO -1.7% -8.4% -8.1% - -
RBY -2.9% -12.4% -6.2% -10.8% -6.2%
UXG -3.4% -11,0% -8.5% -18.7% -

Source - Viewed between the June 7, 2011 close and June 8, 2011 updates. The referenced webpage always shows the 1 day, 1 week, 2 weeks, etc. changes based on the last market close.). '-' denotes metric was not available at GoldMinerPulse. Market capitalization per ounce of gold equivalent based on closing spot market metal prices. Total of reserves + resources ounces are used. Resources and reserves are assumed to be 100% extractable and recoverable.

The above table provides strong evidence that the market valuations of gold stocks has not been keeping pace with the spot market price of gold. Even on a 52 week basis many gold stocks are flat to down while the price of gold is up nearly 25% (see here).

I believe that one of the main reasons explaining this positive divergence between gold spot market prices and gold stock valuations rests with the group think of mining analysts with respect to the future price of gold and silver. Specifically, here are the projected gold and silver prices a well qualified mining analyst (MA, CFA with years of industry experience) was using to value a gold mining junior in a May 2011 report.

Gold and Silver Price Estimates In a May, 2011 Mining Analysts Report

Unit 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E+
gold US$/oz $1,425 $1,425 $1,350 $1,200 $1,100 $1,000 $1,000 $1,000 $1,000
silver US$/oz $36.00 $33.00 $30.00 $28.00 $26.00 $24.00 $22.00 $20.00 $18.00

I am not naming the specific group and analyst responsible for the above estimates, as many analysts are using similar estimates with relatively minor variances (e.g. $1,000 versus $1,050 for the 2016E gold price). Rather, I have provided the above table as a specific example of the typical values mining analysts are currently using. In an April 2011 report, another analyst with a different group increased estimates for the price of silver from $19.50 to $22.00 for 2015E and $18.50 to $20.00 for 2016E.

Given that mining analysts are influential in terms of setting expectations for future stock prices through their NPV / EV and like valuation models, all of which critically depend on an estimate for the future price of gold and silver, it is also not surprising that gold and silver mining stock valuations have not kept pace with the rising price of gold and silver.

From a contrarian investor's perspective, are the mining analysts guilty of a group think mentality with respect to the future price of metals? I would argue yes. Mining analysts have common fiduciary duties enforced by regulatory agencies and many similarities in educational backgrounds and work experiences. Therefore it is not surprising that similar estimates on the future price of gold and silver are being used. As a result, it is also not surprising that the hedge of a long position in physical gold against a short position in gold mining stocks continues to work. Are the hedge funds gaming the mining analysts based on an anticipation of the mining analysts group think mentality? Maybe.

Is the present thinking on the future price of gold and silver perhaps as wrong as the typical analysts views on the soundness of Mortgage-backed securities were in 2005 and 2006? Clearly either the price of gold and silver will trend down in the next few years, or else the market valuations of gold and silver miners will rise significantly. The current status quo of rising gold and silver prices with flat to falling market valuations of gold and silver miners seems unlikely to hold. A review of the excellent interviews available weekly at King World News suggests that gold and silver prices are much more likely to rise than fall in the coming years. That is, the fiscal problems of the U.S., Europe and Japan are not going to be solved through some magic spending formula while spending restraints by our elected officials are unlikely to happen anytime soon. Rather, a slow and orderly devaluation of the U.S. dollar and higher future gold prices is the more likely target scenario.

I would argue that a contrary investor today should be building a long term position in gold stocks as the current positive divergence between the spot price of gold over the market valuations of gold stocks will correct over the long term.

Disclosure: I am long ABX, AEM, RBY.

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